The Inflation and Rising Interest Rates That Never Showed Up
Six
years ago the Federal Reserve hit rock bottom. It had been cutting the
federal funds rate, the interest rate it uses to steer the economy, more
or less frantically in an unsuccessful attempt to get ahead of the
recession and financial crisis. But it eventually reached the point
where it could cut no more, because interest rates can’t go below zero.
On Dec. 16, 2008, the Fed set its interest target between 0 and 0.25 percent, where it remains to this day.
The
fact that we’ve spent six years at the so-called zero lower bound is
amazing and depressing. What’s even more amazing and depressing, if you
ask me, is how slow our economic discourse has been to catch up with the
new reality. Everything changes when the economy is at rock bottom —
or, to use the term of art, in a liquidity trap (don’t ask). But for the longest time, nobody with the power to shape policy would believe it.
What do I mean by saying that everything changes? As I wrote
way back when, in a rock-bottom economy “the usual rules of economic
policy no longer apply: virtue becomes vice, caution is risky and
prudence is folly.” Government spending doesn’t compete with private
investment — it actually promotes business spending. Central bankers,
who normally cultivate an image as stern inflation-fighters, need to do
the exact opposite, convincing markets and investors that they will push
inflation up. “Structural reform,” which usually means making it easier to cut wages, is more likely to destroy jobs than create them.
This
may all sound wild and radical, but it isn’t. In fact, it’s what
mainstream economic analysis says will happen once interest rates hit
zero. And it’s also what history tells us. If you paid attention to the
lessons of post-bubble Japan, or for that matter the U.S. economy in the
1930s, you were more or less ready for the looking-glass world of
economic policy we’ve lived in since 2008.
But
as I said, nobody would believe it. By and large, policy makers and
Very Serious People in general went with gut feelings rather than
careful economic analysis. Yes, they sometimes found credentialed
economists to back their positions, but they used these economists the
way a drunkard uses a lamppost: for support, not for illumination. And
what the guts of these serious people have told them, year after year,
is to fear — and do — exactly the wrong things.
Thus
we were told again and again that budget deficits were our most
pressing economic problem, that interest rates would soar any day now
unless we imposed harsh fiscal austerity. I could have told you that
this was foolish, and in fact I did, and sure enough, the predicted
interest rate spike never happened — but demands that we cut government
spending now, now, now have cost millions of jobs and deeply damaged our
infrastructure.
We
were also told repeatedly that printing money — not what the Fed was
actually doing, but never mind — would lead to “currency debasement and
inflation.” The Fed, to its credit, stood up to this pressure, but other
central banks didn’t. The European Central Bank,
in particular, raised rates in 2011 to head off a nonexistent
inflationary threat. It eventually reversed course but has never gotten
things back on track. At this point European inflation is far below the
official target of 2 percent, and the Continent is flirting with
outright deflation.But are these bad calls just water under the bridge? Isn’t the era of rock-bottom economics just about over? Don’t count on it.
It’s
true that with the U.S. unemployment rate dropping, most analysts
expect the Fed to raise interest rates sometime next year. But inflation
is low, wages are weak, and the Fed seems to realize that raising rates
too soon would be disastrous. Meanwhile, Europe looks further than ever
from economic liftoff, while Japan is still struggling to escape from
deflation. Oh, and China, which is starting to remind some of us of
Japan in the late 1980s, could join the rock-bottom club sooner than you
think.
So
the counterintuitive realities of economic policy at the zero lower
bound are likely to remain relevant for a long time to come, which makes
it crucial that influential people understand those realities.
Unfortunately, too many still don’t; one of the most striking aspects of
economic debate in recent years has been the extent to which those
whose economic doctrines have failed the reality test refuse to admit
error, let alone learn from it. The intellectual leaders of the new
majority in Congress still insist that we’re living in an Ayn Rand novel; German officials still insist that the problem is that debtors haven’t suffered enough.
This
bodes ill for the future. What people in power don’t know, or worse
what they think they know but isn’t so, can very definitely hurt us.
A version of this op-ed appears in print on November 24, 2014, on page A29 of the New York ed
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